Sovereign Wealth Funds

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Introduction

The surfacing of sovereign wealth funds (SWFs) (since 1953) has affected the financial markets and has also reshaped the world’s major economies. SWFs are working since 1953 when first Kuwait Investment Authority was established. Most of the SWFs are created by oil exporting economies like Qatar, United Arab Emirates and Saudi Arabia. These funds are established for the investment out of budget surplus funds. SWFs have surfaced as a great investor. SWFs are important investors for not only capital assets but also for the world-wide equity, enticing, lucrative and growing attention. In recent financial credit crunch SWFs played a key role in stabilizing economies by injecting capital flows Initially SWFs growth were motivated by oil (natural resources) and commodity revenues, but lately the huge budget surpluses experienced by Asian economies put rigor in expansion of SWFs. The investments made in financial institutions during the subprime credit crisis, coined with the speedy growth of SWFs in developing economies, have elevated distress with respect to financial market stability, deficiency of transparent and bad governance structures (Moshirian, 2009) Many researchers have shown their apprehensions regarding these economic power houses like SWFs, which are calculated in trillions of dollars, will be used tactfully and strategically to gain political objectives. Capital and equity assets investments by SWFs are considered to be bias by many researchers throughout the world. SWFs have surfaced as large investors with plenty of resources, and have obtained strategic and sensitive stakes in major firms and banks around the globe. This is seems to be the rising problem for the politically and resourcefully weaken countries to defend their strategic assets from the SWFs giants from acquisitions and control rights in the name of foreign direct investments (FDI). If these funds continue to grow at the same rate as they are to date, the repercussions will be a swing in asset allocations and the appearance of a new investor category in the market. Simultaneously, a worry arises regarding their fear to financial stability, lack of disclosure and non-commercial, and mal fide objectives. This study will contribute to the literature as it coins two studies and tests combined effect of all the variables at once. This study also contribute to the awareness of the economies and governments of resourceful and strategic geopolitical position holding countries to scrutinize foreign direct investments, as SWFs can be used as tool to exploit their resources, with mala fide intentions to achieve political objectives. There are several delimitations of this study. First data is gathered through the few secondary sources due to the limitations of accessing several databases. Hence, its efficacy to be generalized may be compromised. Only publicly available data is used to analyze investment patterns of SWFs. Second limitation is the issue of transparency of SWFs as their scores for transparency varies. Third, many SWFs do not disclose or only reveal incomplete list of their investments. This paper investigates the research question, is there any biasness in investment allocation by SWFs with respect to culture, political, geographical and religious similarity?

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Literature Review

There is no generally established definition of sovereign wealth funds in literature. Sovereign wealth funds (SWFs) are state-controlled investment vehicles which own and manage public funds and they tend to be state-owned and have no explicit liabilities (Moshirian, 2009). Sovereign wealth funds (SWFs) are defined by the US Treasury Department as: government investment vehicles funded by foreign exchange assets and managed separately from official reserves. SWF managers typically have higher tolerance for risk and seek higher returns than do official reserve managers (Blackburn, 2008) The very first source of sovereign wealth is the commodity revenue from natural resource-rich countries. This might be either due to the revenue generated from the tangible sales of the resources or might be the result of tax generated revenue from private firm’s operations in some key commodities (OCED 2008 cited in Moshirian, 2009). The second source of SWFs is hefty current account surpluses (Moshirian, 2009). Due to constant global development and solid macroeconomic fundamentals, commodity based economies gathered significant surplus of foreign exchange earnings and reserves (Balding, 2008). Four principal reasons are stated by Balin (2008) as following: Sovereign wealth funds are created for four principal reasons Firstly, most funds held by natural resource exporters act as intergenerational transfer mechanisms, where future government pensions, asset liquidity, and fiscal revenues are guaranteed by today’s export earnings. Second, most sovereign wealth funds of all country types are created to diversify a country’s income so that it can respond to shocks to the country’s economy. Thirdly, countries establish sovereign wealth funds to increase the return on assets held in their central bank reserves. (p.13) On the other hand some have expressed concerns about SWFs (Gieve, 2008). First apprehension is that SWFs mark militarily, technologically sensitive and strategic industries. Second apprehension is that huge SWFs give their government direct control over global markets (Jhonson 2007, Cited in Chhaochharia & Laeven, 2009). SWFs will negatively alter corporate tactic because they hold strategic chunk stakes and holdings in banks and firms. (Trueman 2007, Cited in Chhaochharia & Laeven, 2009) Many researchers illustrate that historical and cultural variables, for the most part religion and geography also have an effect on the portfolio investment of SWFs. Risk-averse investors prefer to invest in chartered territories rather than sailing in unchartered waters. Such investments into the well-known could entirely be determined by informational advantages, or simply be an appearance of sympathy with the well-known. Such cultural biases are more pronounced for government-owned institutions than for private institutions (Grinblatt & Keloharju, 2001) An example of apprehension in investment receiving economies is concern over political influences, gains and objectives is control of U.S. ports by Dubai Ports World control over operations at six major American ports. A number of U.S. legislators have expressed worry about a potential threat of terror campaign (Radio, 2006). Another recent Example is emphasis of Singaporean SWFs to invest in china and India which has been considered as forging strategic ties with its more powerful neighbors (Bernstein & Schoar, 2009). A SWF can also have a political effect as an alliance-building tool e.g. Singapore’s investments in the United States may deter the U.S. from protectionism, but it also acts to strengthen Singapore’s alliance with the United States generally (Blackburn, 2008). Chhaochharia & Laeven, (2009) further cite many references to show why these variables like geography, religion and similarity affects the financial decision of an individual or financial institution to alter their portfolio investments as following: Geographical and cultural factors, capturing differences in information, trust, or affinity with the familiar, have been found to affect economic outcomes, including the allocation of investment8. For example, Guiso, Sapienza, and Zingales (2007) show that historical and cultural variables, particularly religion, affect trust in people from other countries, and that these differences in trust affect people’s financial decisions, including portfolio and foreign direct investment. Similarly, investors often prefer to invest in familiar investment opportunities as opposed to foreign or unfamiliar investments (Huberman, 2001; Grinblatt and Keloharju, 2001) (p.3) Considerable public attention has attracted towards SWFs recently, in particular on their investments pattern made during the subprime credit crisis in 2007. For these banks and firms, the capital injections made by SWFs provided an increased capital safeguard. This has made easy for banks to continue their operations without challenging them to reduce the size of their assets (Moshirian, 2009). The three variables are identified by (Chhaochharia & Laeven, 2009) i.e. culture, religion, geography. While the fourth variable, i.e. objective of political gain is identified in (Blackburn, 2008). During the recent financial crisis several SWFs invested in different economies which in turn stabilized the capital market of the receiving economy by boosting the investors’ confidence.

Research Methodology

Accepting the above mentioned concerns in literature it is conceivable to link variables of concern to formulate theoretical framework. We have seen all the following variables affecting the investment patterns of SWFs in the literature. Political Gains/Objectives’ variable is taken from (Blackburn, 2008) and Cultural, Geographical and religious similarity variables are taken from (Chhaochharia & Laeven, 2009)

References

  • Chhaochharia, V., & Laeven, L. (2009). The Investment Allocation of Sovereign Wealth. Social Science Research Network.
  • Balding, C. (2008). A Portfolio Analysis Of Sovereign Wealth Funds. Social Science Research Network.
  • Balin, B. J. (2008). Sovereign Wealth Funds: A Critical Analysis. Social Science Research Network.
  • Blackburn, J. (2008). Do Sovereign Wealth Funds Best Serve The Interests of Their Respective Citizens. Social Science Network.
  • Bernstein, S. & Schoar, A. (2009). The investment strategies of Sovereign Wealth Funds. Social Science Network
  • Gieve, J. (2008). Sovereign Wealth Funds and Global Imbalances. Quaterly Bulletin Speeche, 196-202
  • Grinblatt, M., & Keloharju, M. (2001.). “How Distance, Language, and Culture Influence Stockholdings and Trades. Journal of Finance , 1053-1073.
  • Moshirian, F. (2009). Sovereign Wealth Funds and Sub-Prime Credit Problems. Social Science Network.
  • Radio, N. P. (2006, February 20). Marketplace: Concern over Control of U.S. Ports. Retrieved December Monday, 2009, from https://www.npr.org/: https://www.npr.org/templates/story/story.php?storyId=5225229
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